12.2 Why Have Social Insurance?

Asymmetric Information
and Adverse Selection . . . . . . . . . . . . . . . . . . . . . . . . . . . 326
Asymmetric Information 326
Example with Full Information 327
Example with Asymmetric Information 327
The Problem of Adverse Selection 329
Does Asymmetric Information Necessarily Lead to Market Failure? 330
Application: Adverse Selection and Health Insurance Death Spirals 331
How Does the Government Address Adverse Selection? 332

12.3 Other Reasons for Government Intervention

in Insurance Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . 333
Externalities 333
Administrative Costs 333
Redistribution 334
Paternalism 334
Application: Flood Insurance and the Samaritans Dilemma 334

12.4 Social Insurance vs. Self-Insurance:

How Much Consumption Smoothing? . . . . . . . . . . . . . . . . . . 337
Example: Unemployment Insurance 337
Lessons for Consumption-Smoothing Role of Social Insurance 341

12.5 The Problem with Insurance: Moral Hazard . . . . . . . . . . . 342

Application: The Problems with Assessing Workers
Compensation Injuries 343
What Determines Moral Hazard? 344
Moral Hazard Is Multidimensional 344
The Consequences of Moral Hazard 345

12.6 Putting It All Together: Optimal Social Insurance . . . . . . . 346

12.7 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 346

Highlights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347

Questions and Problems . . . . . . . . . . . . . . . . . . . . . . . . . . 347

Advanced Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 348

APPENDIX TO CHAPTER 12 Mathematical Models

of Expected Utility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350

CHAPTER 13 Social Security . . . . . . . . . . . . . . . . . . . . . . 353

13.1 What Is Social Security and How Does It Work? . . . . . . . . 354

Program Details 355
Application: Why Choose 35 Years? 355

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